As you’ve no doubt seen on other personal finance blogs, the Roth IRA is a wonderful and powerful retirement savings tool. It’s also a wonderful and powerful tool for covering necessary expenses right now, tax and penalty-free. However, there are certain Roth IRA withdrawal restrictions. Here’s how to make sure you do it right.
Roth IRA Withdrawal Period
You never have to withdraw funds from a Roth IRA, but you can withdraw funds anytime. Converted assets and earnings can only be withdrawn after a five-year waiting period, but there is no waiting period for contributions. The waiting period begins on January 1 of the tax year of your first contribution. Note that it’s tax year, not calendar year. If you contributed on April 15, 2008 for the 2007 tax year, then the five-year clock started on January 1, 2007 and you can start withdrawing on January 1, 2012. If you contributed on April 15, 2008 for the tax year 2008, then the clock started on January 1, 2008 and you can start withdrawing on January 1, 2013.
Tax and Penalty-Free Roth IRA Withdrawal Limits
Annual contributions can be withdrawn tax and penalty free anytime, for any reason. You can withdraw earnings tax-free and penalty-free if any of the following applies:
- 59 ½ or older
- Deceased (distributions to beneficiaries)
- Up to $10,000 toward purchase of first home.
Penalty-Free Roth IRA Withdrawal Limits
You can withdraw earnings without penalty for specific reasons, but you’ll have to pay regular income tax on the distributions. The penalty-free reasons are:
- Higher education costs
- Medical insurance premiums following a job loss
- Medical expenses more than 7.5% of your adjusted gross income
- Distributions are part of a series of substantially equal payments
- IRS tax levy
- Qualified reservist distribution.
If none of the above apply, you can withdraw earnings, but you’ll pay an additional 10% early withdrawal tax on top of the regular income tax.
The Order of Distribution
The first funds you withdraw are considered your contributions, even if you had gains between contributions. Once you exceed the amount you contributed through annual deposits, you can next withdraw money from IRA conversions. The final withdrawals come from earnings.
When Should You Withdraw?
Even though you can withdraw funds from your Roth IRA, that doesn’t mean you should. Don’t treat it like an emergency fund. Remember, even if you don’t have to pay taxes or penalties, withdrawn money no longer earns gains.
I used my Roth IRA (that had no gains after seven years) to cover a portion of my grad school expenses. Because I had no gains or losses, and the other option was more credit card debt, it was a good deal.
However, you should always look to your emergency fund, then your savings, then maybe even a home equity loan or other sources of funds before you use your retirement funds to pay the bills. Once you get in the habit of poking into your retirement, it’s hard to stop viewing the money as a piggybank. Of course, sometimes the situation is desperate. If you can do it tax and penalty-free, then you shouldn’t feel bad about using the money to put food on the table or pay your medical bills when you have no other options.
See IRS Publication 590 for more information.